We update our investment case for Engro Fertilizers Limited (EFERT) with a Dec21 target price of PkR 73/sh, offering an upside of 12% from the last close. Our revision in estimates is based on: i) rise in domestic urea prices following global trends, and ii) enhancing DAP trading margins as a result of hike in international DAP prices. The stock offers an attractive dividend yield of 16% as opposed to a 3yr/5yr PIB of 9.3%/9.9%. EFERT currently trades at a forward PER of 5.4x as we estimate the company to post earnings of PkR12.1/sh and PkR11.9/sh, in CY21 and CY22, respectively.
Recovering urea prices enhancing pricing power
EFERT increased urea prices by PkR 50/bag in Jan21, resulting in an EPS impact of PkR1.0. International urea prices have increased by 42% CYTD to USD 375/MT as the supply is tight and spring demand kicked off early in 2021. Translated landed price comes at PkR 3,504/bag (a premium of 49% over domestic prices), enhancing the domestic industry’s pricing power and providing potential room to increase urea prices further. To highlight, local prices of urea are primarily dependent on demand-supply dynamics (with a degree of intervention from the federal government) and historically trade at a discount of 23% to the imported counterpart.
Rising DAP prices enhancing trading margins
International DAP prices have remained elevated and touched a high of USD 505/MT as a result of tightened supply on the global scale and firm demand emanating from India. To recall, the U.S. Department of Commerce announced preliminary determinations in the countervailing duty (CVD) investigations of imports of phosphate fertilizers from Morocco and Russia on Nov 24, 2020, increasing the prices of phosphate fertilizer.
Local DAP prices have increased in line with international prices with the average DAP price for EFERT hovering around PkR 4,430/bag. As per the management, DAP prices are expected to remain firm in the short to medium term given the global dynamics of DAP. Moreover, a further hike in domestic prices is a definite possibility as global DAP prices continue to remain elevated. Our calculation suggests that at the average running price of USD482/MT, derived local DAP price comes at PkR 4,900/bag, indicating further room of PKR 500/bag for additional price hikes. The relative price sensitivity of commodity, however, may limit potential hikes.
Fertilizer subsidy is on cards
Farmers being highly sensitive to fertilizer prices would naturally shift to affordable fertilizer in light of rising DAP prices. Therefore, timely implementation of DAP subsidy worth PkR 5.4bn is needed to keep the DAP price affordable for farmers and boost agronomic demand in 2021.
Early expiration of concessionary gas remains a key risk
There is still uncertainty regarding the expiry of concessionary gas supply agreement and remains a major risk to our investment case. Based on the contract’s time-line of 10 years, the concessionary gas tariff of USD 0.7/mmbtu is expected to expire in Jun21 as the EnVen project achieved CoD in 2011. However, based on the management’s assessment of the contractually allotted quantum of supply, the concessionary gas supply agreement should expire in 1HCY24. Post expiry, the price of feed gas would be charged at normalized gas rate under the Fertilizer Policy.
GIDC payment extended in 48 monthly installments
With regards to GIDC payment, the company owes ~PkR 20bn to the government on non-concessionary gas in 48 equal monthly installments, extending from the original 24 month timeline. The company has already provided for GIDC in its accounts; therefore, the payment is expected to have limited impact on the company’s projected profitability. We estimate a reduction in other income by PkR 0.77/sh on a recurring basis on account of the lower cash balance. To highlight, fertilizer industry (including EFERT) has recently obtained a stay order with regards to the payment of GIDC and the company is not paying any amount as of now. However, the payment has been incorporated in our valuations.
Recommendation – ‘BUY with Price Target PKR 73/sh!
We reiterate our ‘BUY’ recommendation on EFERT with our price target at PKR 73/sh, with an upside potential of 12% from current levels. The stock offers an attractive dividend yield of 16% during CY21-CY23 and 12% after the expiry of concessionary gas, way above the 3yr/5yr/10yr PIB of 9.3%/9.9%/10.3%. EFERT trades at CY21 and CY22 forward PER of 5.4x and 5.5x.